All market timers, traders and investors, in every kind of
market, feel fear at some level. Turn on the news one day and
hear that a steep unexpected sell-off is taking place, and most
of us will get a queasy feeling in our stomachs.
But the key to successful “profitable” market timing, in fact
all trading, is in how we prepare ourselves to handle trading
fears. How we prepare to deal with the risks inherent in trading.
Mark Douglas, an expert in trading psychology, says this about
trading fears in his book “Trading in the Zone.”
“Most investors believe they know what is going to happen next.
This causes traders to put too much weight on the outcome of the
current trade, while not assessing their performance as “a
probability game” that they are playing over time. This
manifests itself in investors getting too high and too low and
causes them to react emotionally, with excessive fear or greed
after a series of losses or wins.
As the importance of an individual trade increases in the
trader’s mind, the fear level tends to increase as well. A
trader becomes more hesitant and cautious, seeking to avoid a
mistake. The risk of choking under pressure increases as the
trader feels the pressure build.
All traders have fear, but winning market timers manage their
fear while losing timers (as well as all traders) are controlled
by it. When faced with a potentially dangerous situation, the
instinctive tendency is to revert to the “fight or flight”
response. We can either prepare to do battle against the
perceived threat, or we can flee from this danger.
When an investor interprets a state of arousal negatively as
fear or stress, performance is likely to be impaired. A trader
will tend to “freeze.”
There are four major trading fears. We will discuss them here,
as well as how to handle them. Fear Of Losing
The fear of losing when making a trade often has several
consequences. Fear of loss tends to make a timer hesitant to
execute his or her timing strategy. This can often lead to an
inability to pull the trigger on new entries as well as on new
exits.
As a market timer, you know that you need to be decisive in
taking action when your strategy dictates a new entry or exit,
so when fear of loss holds you back from taking action, you also
lose confidence in your ability to execute your timing strategy.
This causes a lack of trust in the strategy or, more
importantly, in your own ability to execute future signals.
“When you’re having trouble pulling the trigger, realize that
you are worrying too much about results and are not focused on
your execution process.” For example, if you doubt you will
actually be able to exit your position when your strategy tells
you to get the out, then as a self-preservation mechanism you
will also choose not to get into a new trade. Thus begins
analysis paralysis, where you are merely looking at new trades
but not getting the proper reinforcement to pull the trigger. In
fact, the reinforcement is negative and actually pulls you away
from making a move.
Looking deeper at why a timer cannot pull the trigger, a lack of
confidence causes the timer to believe that by not trading, he
is moving away from potential pain as opposed to moving toward
future gain.
No one likes losses, but the reality is, of course, that even
the best professionals will lose. The key is that they will lose
much less, which allows them to remain in the game both
financially and psychologically. The longer you can remain in
the trading game with a sound timing strategy, the more likely
you will start to experience a better run of trades that will
take you out of any temporary trading slumps.
When you’re having trouble pulling the trigger, realize that you
are worrying too much about results and are not focused on your
execution process.
By following a strategy that unemotionally tells you when to
enter and exit the market, you can avoid the pitfalls caused by
fear.
This, of course, is what we do here at FibTimer. We learned long
ago that unemotional (non-discretionary) timing strategies save
us during emotional times in the market. We know the strategies
work, so we put aside our fears, and make the trades. “…good
timing strategies are designed to guard against big losses” And
remember, you must be able to take a loss. Consider them as part
of trading. If you cannot, you will not be around for the big
gains because you will be on the sidelines guarding your capital
against that potential loss.
Remember that good timing strategies are designed to guard
against big losses. Every trade you take has the potential to
become a loss, so get used to this reality and take every buy
and sell signal. That way, when the next big trend starts, you
will be onboard and profit from it.
Fear Of Missing Out
Every trend always has its doubters. As the trend progresses,
skeptics will slowly become converts due to the fear of missing
out on profits or the pain of losses in betting against that
trend.
The fear of missing out can also be characterized as greed of a
sorts, for an investor is not acting based on some desire to own
the stock or mutual fund - other than the fact that it is going
up without him on board.
This fear is often fueled during runaway booms like the
technology and internet bubble of the late-1990s, as investors
heard their friends talking about newfound riches. The fear of
missing out came into play for those who wanted to experience
the same type of euphoria.
When you think about it, this is a very dangerous situation, as
at this stage investors tend essentially to say, “Get me in at
any price - I must participate in this hot trend!
The effect of the fear of missing out is a blindness to any
potential downside risk, as it seems clear to the investor that
there can only be gains ahead from such a “promising” and
“obviously beneficial” trend. But there’s nothing obvious about
it.
Remember the stories of the Internet and how it would
revolutionize the way business was done. While the Internet has
indeed had a significant impact on our lives, the hype and
frenzy for these stocks ramped up supply of every possible
technology stock that could be brought public and created a
situation where the incredibly high expectations could not
possibly be met in reality.
It is expectation gaps like this that often create serious risks
for those who have piled into a trend late, well after it has
been widely broadcast in the media to all investors.
Next week read part 2, the conclusion of this article on
“Trading Fears.”
